You see them everywhere. They have names like "Cash City" and "Check Advance" and "Rapid Cash." Nevada has more payday loan companies than it has McDonalds and Starbucks combined. But how do they work? Nevada is one of a handful of states with no regulations on payday loan centers. This means that it's something of a wild wild west out there and if you don't know how it works, you can get hurt.
Let me start with this piece of advice:
Avoid payday loans whenever possible!
Having said that, let's go into what a payday loan is, and what they do in Nevada.
A payday loan is a short-term loan. In the old days they used to operate like this: You would write them a check, and they would give you cash. Then they would hang onto the check for 2 weeks before cashing it. The idea is that you might need money, and you know you'll be getting money when you get paid, so you ask to get that cash "in advance."
Today, payday loans are somewhat more creative, but the idea is the same. It's a short term, super expensive loan.
So what's the problem? Why are payday loans forbidden in some states? Here are some reasons.
You have to pay back these short term loans all at once.
You can't make payments on these loans. You have to pay it all back. So consider this: you borrow 500 dollars and pay the 75 dollar fee. You take care of whatever problem you have, but in 2 weeks you find you don't have quite enough to pay back the 500 dollars. So you have to either renew the loan or take out a new payday loan from another provider. That's another 75 dollars, and you still owe 500 dollars.
On and on it goes. After just a couple of months, most people have paid the full amount of the loan in interest, but still owe the whole 500 dollars. If it takes you a full year to pay off the loan, your interest payments will have been 5 times the amount you originally borrowed. That means for a 500 dollar loan, you will have paid $2500 in interest and still owe the original $500. Sound like a good deal?
The interest rate is over 500%
Payday loan operators always complain about this number. They say it's not true. Most say "No, our loans are only 20%." But the reality is it's 20% for 2 weeks. If we're talking about APR, which is the universal method for calculating interest, it's an average of 521%.
If you're thinking about taking a payday loan, multiply the amount you're borrowing by 5, then imagine taking an annual pay cut by that amount. Can you afford it? Because that's what your payday loan is going to do, whether it lasts for 2 weeks or a year.
Most people take at least 5 months to pay it back.
The Pew Charitable Trust did some research and found that most folks took 5 months to pay back the loan they thought they would be able to repay in 2 weeks. In the end, their ability to pay it back came from either borrowing from family or friends, or using their tax return.
If you're living paycheck to paycheck, a payday loan can take away from your already strapped spending power and cause you to spiral into debt, default, and bankruptcy.
What are alternatives to payday loans?
Most people who consider payday loans are looking to avoid asking for help, or they aren't aware of other options. For example, people often think that using credit cards is too expensive, but even at 27% interest, a payday loan is 19 times more expensive than a credit card. Here are some options to consider:
1. Ask for help. Ask your family or friends. The sad reality is that most people have to go to family or friends anyway just to pay off a payday loan.
2. Use your credit. Your bank account may have a line of credit. Even though this is not an optimal solution, it's going to be cheaper and easier to pay off than a payday loan.
3. Set aside money NOW! Avoiding the trap of payday loans can be done if you can manage to start saving long before the crisis hits. Instead of paying a 50 dollar fee each month for your 370 dollar loan, set aside 50 dollars into a savings account.
4. Peer lending. There are online lending companies which might help. It isn't quick, but you can get a loan from individuals online. Sites like prosper.com and lendingclub.com say that people with good credit can get a loan for under 10% interest.